Question

A) Low gearing is preferable to high gearing
B) 'Acid test' denotes liquidity
Of these:

• A. Both (a) and (b) are true
• B. Both (a) and (b) are false
• C. (a) is true but, (b) is false
• D. (a) is false but (b) is true

Answer 1

Answer: (A)

Both (a) and (b) are true

a) A gearing ratio higher than 50% is typically considered highly levered or geared. As a result, the company would be at greater financial risk, because during times of lower profits and higher interest rates, the company would be more susceptible to loan default and bankruptcy.

b) The acid-test ratio is used to indicate a company's ability to pay off its current liabilities The higher the ratio, the better the company's liquidity and overall financial health. A ratio of 2 implies that the company owns $2ofliquidassetstocovereach$1 of current liabilities.